Every company has fixed assets, and you’re probably reading this on one right now. Fixed assets are purchases your company makes that add value to the business and that help your company make money. The best examples are computers, office furniture and company cars. These are purchases that will benefit the business for more than a year.The matching principle in GAAP accounting requires us to match revenues with the expenses that generate that revenue. But if you write off major asset purchases when you buy them, that violates matching: you get a big deduction the first year, but nothing after that, even though the company will continue to benefit from them for years to come. Those big swings in expenses distort income, making company performance seem worse or better than it really is. Depreciation is how we solve that problem.

What Is Depreciation?

Outside of the accounting world, depreciation means the decline in value of an item after purchase. In accounting, depreciation is the process of allocating the cost of an item over its anticipated useful life. This helps to ensure that company revenues are matched with the costs of assets used by a company to generate that revenue.

How Do I Calculate Depreciation?

When assets are purchased, they are recorded at their historical cost in an asset account on the balance sheet. At the end of every accounting period, a depreciation journal entry is recorded as part of the usual periodic adjusting entries.To calculate depreciation expense, you need to know four things:

• Cost. The depreciable basis of an asset includes all the costs to acquire the item and place it in service. This includes the purchase price, plus any shipping, taxes. installation, or customization costs you pay to get that item ready for use. 
• Depreciation method – Straight-line (evenly over the useful life) vs. accelerated depreciation (double the rate, early in the life of the asset). Straight-line depreciation is the easiest to calculate, but for tax purposes, accelerated depreciation front-loads depreciation expense to provide a bigger tax deduction early on. 
• Useful life – Each asset class has a different useful life. The most common classes we see are 5 years (computers) or 7 years (office furniture).
• Residual value or salvage value – What you can sell your asset for at the end of its useful life. Your basis for depreciation will be original cost minus salvage value. In practice, most accountants assume this is close enough to zero that it can be ignored. 

For example, let’s say on April 1, an organization purchases a laptop for $1,000 and estimates that it will last five years with zero residual value. The annual depreciation expense will be $200 ($1,000 / 5 years), and the monthly depreciation expense will be $16.67, rounded to $16.70 ($1,000 / 60 months).The journal entry to record the purchase of the laptop is as follows:DateAccount NameDRCR4/1/21Fixed Asset - Computers$1,000Cash$1,000

How Do I Record Depreciation?

Depreciation is recorded as a debit to a depreciation expense account and a credit to a contra asset account called accumulated depreciation. Contra accounts are used to track reductions in the valuation of an account without changing the balance in the original account. In the financial statements, depreciation expense shows up in the income statement, and accumulated depreciation is grouped with the fixed assets on the balance sheet.Let’s look at the bookkeeping entry to record depreciation for our laptop:DateAccount NameDRCR4/30/21Depreciation Expense$16.70Accumulated Depreciation $16.70This depreciation journal entry will be made every month until the balance in the accumulated depreciation account for that asset equals the purchase price or until that asset is disposed of.As a contra account, accumulated depreciation reduces the book value of that asset on the balance sheet. The net book value of an asset is determined by taking the sum of the fixed asset account – which has a debit balance – and the accumulated depreciation account – which has a credit balance. Over time, the net book value of an asset will decrease until its salvage value is reached.It’s important to note that the book value of an asset may differ significantly from its market value. A good example is a car, which can lose 30% of its market value as soon as you drive it off the lot, but its book value on the balance sheet will still be pretty close to the purchase price. If the market value of an asset changes materially, U.S. GAAP only allows downward adjustments from historical cost, which are called impairment losses. This is a difference from IFRS, which allows for both upward and downward asset revaluation.Let’s say that on May 1, 2025, the company replaces that laptop with a newer one, and sends the old one to be recycled. With four full years of depreciation, the accumulated depreciation account shows a credit balance for that laptop of $800. This means the net book value of the asset is $200 ($1,000 - $800). In the year of disposal, you write off any remaining value as a loss. Here’s the bookkeeping entry to record the disposal of the laptop:DateAccount NameDRCR5/1/25Accumulated Depreciation$800Loss on Disposal$200Fixed Asset - Computers$1,000Other items of note:Depreciation is a non-cash entry for your company, meaning no cash is going out of your bank account for this expense item. This becomes a factor in your statement of cash flows.If you’re using different depreciation methods for your GAAP-basis financials and for tax purposes, you’ll have a book-tax difference for depreciation, which will go into calculating the company’s tax provision.Intangible assets, such as trademarks or patents are not depreciated, but amortized. Amortization follows the same concept as depreciation, but the method is nearly always straight line.Want to learn more about the details of journal entries? Check out our library of helpful posts right here.